What’s been disturbing, however, is the parade of first-rate economists making totally non-serious arguments against fiscal expansion. You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems. You’ve got John Cochrane going all Andrew-Mellon-liquidationist on us. You’ve got Eugene Fama reinventing the long-discredited Treasury View. You’ve got Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw — well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone opposed to stimulus, regardless of the quality of their argument.

Meanwhile, it’s getting really ugly out there in economic environment. In sudden change of weather, sky is all covered with dark clouds, as if heavy pouring is going to start any minute.
I’m getting really really bad feeling that something sinister is about to happen.

What exactly is global financial crisis?
The financial crisis triggered by bust in US housing bubble spread across the entire US financial sector and went on to cripple the global economy.

How did we get here?
– US housing market ballooned during 2003 – 2006.
– People bought houses on borrowed money, even though they did not have enough income to support such loans. This became popularly known as Subprime mortgages. When house prices started falling, loans became costlier, people abandoned their loans and houses.
– Financial institutions who lent this money (Citi, Lehman, Goldman Sachs, Hedge Funds etc.), mortgage insurers who guaranteed these loans (Fannie Mae, Freddie Mac, AIG etc), houseowners whi had to abandon their loans and homes – more people lost in this trade. So who earned all this money? Home builders and stakeholders in real-estate industry who sold the houses, material suppliers and commodity producers who supplied raw material at higher prices – few people earned large sums of money taking other side of the trade.
– So if money only changed hands why the whole system is affected? Money went from banking system to private hands. Banks lost the capital and ability of credit creation in multiples. Part of the money went outside US in the form of investments and consumption of imported goods and commodities. Result of all this – credit crunch due to contraction of capital in banking system, worsening global economy partly due to cyclically high interest rates and partly due to capital losses in US housing markets, dying exports, falling commodity prices and lack of investments.

Who to blame? (consensus list of various economists and market comentators)– excessive deregulation of US financial markets, specifically complex Over The Counter (OTC) derivatives contracts
– originate-to-distribute model of mortgage securitization where the risk is assumed by the party who is not the originator of the risk
– lose credit policy by Alan Greenspan, keeping interest rates too low for too long
– Enormous Leverages taken by non deposit taking financial institutions like Bear Sterns

Where do we stand today?
On a brink of severe global recession, which will probably last until early 2010.

Indicators of the extent of the crisis– US unemployment at 6.5%, world moving behind US in lockstep.
– US institutions going bankrupt/taken over/bailed out: Bear Sterns, Lehman Brothers, Fannie Mae, Freddie Mac, AIG, Washington Mutual, Wachovia bank
– US Gov’t is investing in private sector on massive scale. Also buying troubled mortgage assets under 700B$ TARP (Troubled Assets Relief Program)
– Emerging market stock indices down 60% from peak
– S&P500 down 35% YTD
– TED spread (measure of credit crunch in USD lending) reached peaked 500 bps and after intervention by several central banks still stands at 250bos. The normalcy level for TED spread is 50 bps.
– VIX, volatility index which is a measure of fear in financial markets and generally fluctuates between 20-60, reached its highest level of 80 and is above 60 for several weeks in a row now.
– Countries probably already in recession (successive 2 quarters of negative growth) US, UK, New Zealand, Australia and several economies in Europe.
– Emerging markets slowing down. Growth estimates for China down to 8% from 12%, for India down to 6% from 9%.

About

08 November 2008
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It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …